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Optimal Dynamic Risk Sharing when Enforcement is a Decision Variable

  • Thorsten Koeppl

    ()

    (Department of Economics, Queen's University)

Societies provide institutions that are costly to set up, but able to enforce long-run relationships. We study the optimal decision problem of using self-governance for risk sharing or governance through enforcement provided by these institutions. Third-party enforcement is modelled as a costly technology that consumes resources, but permits the punishment of agents who deviate from ex-ante specified allocations. We show that it is optimal to employ the technology whenever commitment problems prevent first-best risk sharing, but never optimal to provide incentives exclusively via this technology. Commitment problems then persist and the optimal incentive structure changes dynamically over time with third-party enforcement monotonically increasing in the relative inequality between agents.

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File URL: http://qed.econ.queensu.ca/working_papers/papers/qed_wp_1050.pdf
File Function: First version 2005
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Paper provided by Queen's University, Department of Economics in its series Working Papers with number 1050.

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Length: 43 pages
Date of creation: Jan 2005
Date of revision:
Publication status: Forthcoming in Journal of Economic Theory
Handle: RePEc:qed:wpaper:1050
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  1. Kocherlakota, Narayana R, 1996. "Implications of Efficient Risk Sharing without Commitment," Review of Economic Studies, Wiley Blackwell, vol. 63(4), pages 595-609, October.
  2. Garey Ramey & Joel Watson, 1999. "Contractual Intermediaries," Cowles Foundation Discussion Papers 1235, Cowles Foundation for Research in Economics, Yale University.
  3. Stefan Krasa & Anne P. Villamil, 2000. "Optimal Contracts when Enforcement Is a Decision Variable," Econometrica, Econometric Society, vol. 68(1), pages 119-134, January.
  4. Ligon, Ethan & Thomas, Jonathan P & Worrall, Tim, 2002. "Informal Insurance Arrangements with Limited Commitment: Theory and Evidence from Village Economies," Review of Economic Studies, Wiley Blackwell, vol. 69(1), pages 209-44, January.
  5. Spear, Stephen E & Srivastava, Sanjay, 1987. "On Repeated Moral Hazard with Discounting," Review of Economic Studies, Wiley Blackwell, vol. 54(4), pages 599-617, October.
  6. Garance Genicot & Debraj Ray, 2003. "Group Formation in Risk--Sharing Arrangements," Review of Economic Studies, Wiley Blackwell, vol. 70(1), pages 87-113, January.
  7. Ethan Ligon & Jonathan P. Thomas & Tim Worrall, 1998. "Mutual Insurance, Individual Savings and Limited Commitment," Keele Department of Economics Discussion Papers (1995-2001) 98/14, Department of Economics, Keele University.
  8. Avinash Dixit, 2001. "On Modes of Economic Governance," CESifo Working Paper Series 589, CESifo Group Munich.
  9. Phelan Christopher, 1995. "Repeated Moral Hazard and One-Sided Commitment," Journal of Economic Theory, Elsevier, vol. 66(2), pages 488-506, August.
  10. Rustichini, Aldo, 1998. "Dynamic Programming Solution of Incentive Constrained Problems," Journal of Economic Theory, Elsevier, vol. 78(2), pages 329-354, February.
  11. Thomas, Jonathan & Worrall, Tim, 1988. "Self-enforcing Wage Contracts," Review of Economic Studies, Wiley Blackwell, vol. 55(4), pages 541-54, October.
  12. Timothy J. Kehoe & David K. Levine, 1992. "Debt constrained asset markets," Working Papers 445, Federal Reserve Bank of Minneapolis.
  13. Gauthier, Celine & Poitevin, Michel & Gonzalez, Patrick, 1997. "Ex Ante Payments in Self-Enforcing Risk-Sharing Contracts," Journal of Economic Theory, Elsevier, vol. 76(1), pages 106-144, September.
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